The present invention relates to a method and a system for increasing the security against undesired matches in an automated exchange system.
In existing automated exchange systems for continuous trading (dealer market), a simple first in first served model in the matching is commonly used. Thus, if there is a selling price, which is matched by a buying price, the two orders are matched.
To increase liquidity there are Market Makers (quoters) who are required by the exchange to continuously enter two way quotes. The basic idea is that market makers must have a two way quote in the market all the time. The quotes (together with ordinary orders) creates a best bid and offer that is sent out as the exchange official price. The best bid or offer is used by investors when deciding about buying or selling an instrument. It is in the exchange interest to have as tight spread, i.e. the small difference between the selling price and the buying price, as possible between the best bid and the best offer in order to attract investors. It is also in the exchange interest to have a lot of volume (many contracts) available to the investors, both at the best bid and offer and at a worse price.
In other words, since a market maker is required to continuously have a two way quote, i.e. both a selling price and a buying price, if the price goes up (or down) the market makers will adjust their prices. However, if there is a delay in the communication path between a market maker and the automated exchange system or a market maker is slow to enter his new prices into an existing automated system the system will automatically match bids, even though this never was the intention of the market maker only being slow to enter his new prices or the new prices having been delayed for some reason.
In today""s automated exchange systems the market makers solve this problem by having quite a large spread, i.e. a large difference between their selling price and their buying price.
Thus, if the prices on the market starts to change, the market maker has a buffer in that he has entered a large spread, and he will thus have more time to correct his prices.
However, as pointed out above, it is in the exchange interest to have as tight spread as possible between the best bid and the best offer in order to attract investors. Therefore, it is desired that the spread be smaller than it is today, without forcing the market makers to take the risk of making undesired matches.
Furthermore, today""s automated exchange systems does not support that market makers act differently with respects to different counterparts or types of counterparts.
It is an object of the present invention to overcome the problems as outlined above and to provide an automated exchange system having functionality which makes it possible for market makers to act differently with respect to different counterparts and which therefore can cope with situations where matching bids should not be matched, and thereby making it possible for market makers to enter two way quotes having a very small spread without taking the risk of making undesired matches.
This object and others are obtained by a method and a system wherein a market maker can enter a course of action in advance, so that the volume in the orderbook is continuously updated, and where the updating is performed differently with respect to different counter parts. Also, quotes that may result in a trade between market makers are hidden for some time before being matched, thus giving the market makers a chance to back off.
Thus, the system employs a function that supports that market makers through pre-defined parameters will have new orders automatically generated by the system and that a market maker can act differently with respect to different counterparts. The parameters specify if a market maker should add extra volume on an existing price or generate a new order at a worse price.
Thus, in order to support market makers to have a very tight spread additional logic is used when matching orders. The algorithm used for this purpose protects the market makers in certain situations and gives market makers the possibility to have a tight spread without taking a large risk. The algorithm also supports that the market makers can take the risk to quote large volumes.
The algorithm uses a set of parameters, which are predefined by each market maker. The parameters are for example:
Firm limit parameter, which restricts how much of a quote may be traded against a firm order or a market maker order/quote.
Step-up buffer parameter, which is used for determining when to increase the volume on the market.
Tick worse volume parameter, which is used for automatically placing new quotes on the market.
The algorithm is executed when a market maker participates in a trade. In a preferred embodiment there are three different methods in the algorithm depending on the counterpart in the trade
Thus, when the counterpart is a customer the market maker participates in the trade with the full volume.
If the market maker full volume at the best price is traded, and the customer order indicates that it wants to trade more (volume and price indicates further matching) the tick worse parameter generates new quotes in accordance with an algorithm described below.
When the trade is executed a check is done of the total volume at the best bid/offer. If the volume is less than X, which is a parameter predefined by the exchange, the step-up parameter is used to automatically generate more volume in the market makers existing quote. If the parameter indicates to not generate more volume the tick one worse parameter instead generates new quotes.
When the counterpart is a firm the market maker participates in the trade with the firm volume. This supports that the market maker can have reduced volume (risk) when trading with firms.
If the market maker firm volume at the best price is traded, and the firm order indicates that it want to trade more (volume and price indicates further matching) the tick one worse parameter generates new quotes.
When the trade is executed a check is done of the total volume at the best bid/offer. If the volume is less than X, which is a parameter predefined by the exchange, the step-up parameter is used to automatically generate more volume in the marketmaker""s existing quote. If the parameter indicates to not generate more volume the tick one worse parameter instead generates new quotes.
When the counterpart is a market maker no match takes place. Instead the incoming order is inserted into the order book but no update of the best bid offer is sent out, i.e. now there are quotes in the order book crossing but it is not sent out in the best bid/offer. After a time Y, which is predefined by the exchange, the algorithm checks if there still is a lock, i.e. matching prices, in the order book, and if so the orders are matched.
If the counterpart is another market maker, the market maker participates in the trade with the firm volume. This supports that market makers do not take the risk to trade with other market makers just because they are a bit slow to send in new quotes. This also supports that the market maker can have reduced volume (risk) when trading with other market makers.
If the market maker full volume at the best price is traded, and the opposite market maker quote indicates that it wants to trade more (volume and price indicates further matching) the one tick worse parameter generates new quotes.
The method and system as described herein makes it possible for a market maker to act differently with respect to different counterparts. This makes the risks which the market maker has to take lower, and therefore the market maker can reduce the spread, which in turn will increase the attraction on investors.